UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549








FORM
10-Q












r QUARTERLY REPORT
UNDER SECTION 13 OR 15(d) OF THE SECURITIES


EXCHANGE
ACT OF 1934





FOR THE QUARTERLY PERIOD
ENDED: June 30, 2008





r TRANSITION REPORT
UNDER SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934




For the
transition period from _________ to ___________





Commission file number
000-27465




INNOVATIVE
SOFTWARE TECHNOLOGIES, INC.


(Exact
name of small business issuer as specified in its charter)




Delaware
            
            26-1469061(State
      or other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer Identification No.)911
      Ranch Road 620 N., Suite 204
              Austin,
      TX 78734
              (Address
      of principal executive offices)




(512)
266-2000


(Registrant’s
Telephone Number, Including Area Code)




Securities
      Registered Pursuant to Section 12(b) of the Act: NoneSecurities
      Registered Pursuant to Section 12(g) of the Act: Common Stock, $0.001 par
      Value




Check
whether the issuer: (1) filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. YES x    NO
o
 
 Indicate
by check mark whether the issuer is a shell company (as defined in Regulation
12b-2 of the Exchange Act): YES oNO x
 
 State the
number of shares outstanding of each of the issuer's classes of Common equity,
as of the latest practicable date:
 
 103,514,199 Common
Shares (post-reverse split) outstanding as of August5,
2008
 
 Transitional
Small Business Disclosure Format: YES o    NO
x
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
  (Check
One):
  Large
      Accelerated filer r
                Accelerated
      filer                   rNon-accelerated
      filer    r
                  (Do
      not check if a smaller reporting company)
                Smaller
      reporting company þ


i
 Table of Contents




Tableof Contents




PagePART
      I.
            FINANCIAL
      INFORMATIONItem
      1.
            Financial
      StatementsConsolidated Balance Sheet as of June 30, 2008 (unaudited) and
      March 31, 2008
            
            F-1Consolidated
      Statements of Operations for the three monthsEnded June 30,
      2008 and 2007 and for the period from inception(January 12, 2005)
      through June30,
      2008(unaudited)
            
            F-2Consolidated
      Statements of Cash Flows for the three  monthsEnded June 30, 2008 and 2007 and for the period from
      inception(January 12, 2005)
      through June 30, 2008 (unaudited)
            
            F-3Notes to
      Consolidated Financial Statements (unaudited)
            
            F-4Item
      2.
            Management's
      Discussion and Analysis or Plan of Operation
            
            F-13Item
      3.
            Controls and
      Procedures
            
            F-16PART
      II.
            OTHER
      INFORMATIONItem
      1.
            Legal
      Proceedings
            
            1Item
      2.
            Unregistered Sales
      of Equity Securities and Use of Proceeds
            
            1Item
      3.
            Defaults Upon
      Senior Securities
            
            1Item
      4.
            Submission of
      Matters to a Vote of Security Holders
            
            1Item
      5.
            Other
      Information
            
            1Item
      6.
            Exhibits
            
            1SIGNATURES
            
            2






ii
 Table of Contents







INTRODUCTORY
NOTE





This
Report on Form 10-Q for Innovative Software Technologies, Inc., (the “Company”)
may contain forward-looking statements. You can identify these statements by
forward-looking words such as “may,” “will,” “expect,” “intend,” “anticipate,”
“believe,” “estimate,” and “continue” or similar words. Forward-looking
statements include information concerning possible or assumed future business
success or financial results. You should read statements that contain these
words carefully because they discuss future expectations and plans, which
contain projections of future results of operations or financial condition or
state other forward-looking information. We believe that it is important to
communicate future expectations to investors. However, there may be events in
the future that we are not able to accurately predict or control. Accordingly,
we do not undertake any obligation to update any forward-looking statements for
any reason, even if new information becomes available or other events occur in
the future.





The
forward-looking statements included herein are based on current expectations
that involve a number of risks and uncertainties set forth under “Risk Factors”
in this report and in our Form 10-KSB and any other periodic reports filed with
the SEC. Accordingly, to the extent that this Quarterly Report contains
forward-looking statements regarding the financial condition, operating results,
business prospects or any other aspect of the Company, please be advised that
the Company’s actual financial condition, operating results and business
performance may differ materially from that projected or estimated by the
Company in forward-looking statements.









iii
 Table of Contents




INNOVATIVESOFTWARE TECHNOLOGIES, INC.


CONSOLIDATED
BALANCE SHEET


(A
Development Stage Company)





June
      30,
            
            
            March
      31,2008
            
            
            2008Assets
            
            (unaudited)Current
      assetsCash
      and cash equivalents
            
            $
            76,188
            
            
            $
            29,126Accounts
      receivable, net
            
            
            -
            
            
            
            8,450Prepaid
      services and other current assets
            
            
            839
            
            
            
            839Total
      current assets
            
            
            77,027
            
            
            
            38,415Property
      and equipment, net (note 4 )
            
            
            100,014
            
            
            
            114,487Deposits
      and other assets
            
            
            2,400
            
            
            
            2,400Total
      assets
            
            $
            179,441
            
            
            $
            155,302Liabilities
      and stockholders' deficitCurrent
      liabilitiesAccounts
      payable and accrued liabilities
            
            $
            752,828
            
            
            $
            725,400Accrued
      taxes
            
            
            7,152
            
            
            
            4,475Accrued
      interest
            
            
            115,658
            
            
            
            89,727Accrued
      officer salary and expenses
            
            
            34,071
            
            
            
            58,500Advances
      payable (note 3)
            
            
            50,000
            
            
            
            155,511Current
      portion of capital lease obligation
            
            
            43,898
            
            
            
            57,559Deferred
      revenue (note 5)
            
            
            170,560
            
            
            
            112,781Penalty
      for late registration
            
            
            81,140
            
            
            
            81,140Deferred
      gain of sale of fixed assets
            
            
            3,545
            
            
            
            4,874Note
      payable
            
            
            158,079
            
            
            
            -Convertible
      debentures (note 6)
            
            
            104,003
            
            
            
            70,394Total
      current liabilities
            
            
            1,520,934
            
            
            
            1,360,361Commitments
      and contingencies (note 9)
            
            
            -
            
            
            
            -Stockholders'
      deficitPreferred
      stock, 25,000,000 shares authorized, no par value:Series
      A, 1,500,000 shares authorized, 450,000 shares outstanding
            
            
            450,000
            
            
            
            450,000Common
      stock, $0.001 par value; 300,000,000 shares authorized;102,514,199 and 101,184,199 shares issued and outstanding at June 30,
      2008 and March 31, 2008, respectively (note 7)
            
            
            102,515
            
            
            
            101,185Additional
      paid-in capital
            
            
            3,283,112
            
            
            
            3,142,017Deficit
      Accumulated during the Development Stage
            
            
            (5,177,120
            )
            
            
            (4,898,261
            )Total
      stockholder's deficit
            
            
            (1,341,493
            )
            
            
            (1,205,059
            )Total
      liabilities and stockholders' deficit
            
            $
            179,441
            
            
            $
            155,302





The
accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.







F-1
 Table of Contents





INNOVATIVESOFTWARE TECHNOLOGIES, INC.


CONSOLIDATED
STATEMENTS OF LOSSES AND COMPREHENSIVE LOSS


(A
Development Stage Company)


(Unaudited)








Cumulative
      fromFor
      the Three
            
            
            For
      the Three
            
            
            InceptionMonths
      Ended
            
            
            Months
      Ended
            
            
            (January
      12, 2005)June
      30,
            
            
            June
      30,
            
            
            June
      30,2008
            
            
            2007
            
            
            2008Revenue
            
            $
            109,942
            
            
            $
            32,140
            
            
            $
            451,100Total
      revenue
            
            
            109,942
            
            
            
            32,140
            
            
            
            451,100Cost
      of revenue
            
            
            37,659
            
            
            
            21,712
            
            
            
            190,917Total
      cost of revenue, excluding depreciation below
            
            
            37,659
            
            
            
            21,712
            
            
            
            190,917Gross
      profit
            
            
            72,283
            
            
            
            10,428
            
            
            
            260,183Operating
      expenses:Sales,
      general and administrative expenses
            
            
            284,901
            
            
            
            330,500
            
            
            
            4,211,632Total
      operating expenses
            
            
            284,901
            
            
            
            330,500
            
            
            
            4,211,632Operating
      loss
            
            
            (212,618
            )
            
            
            (320,072
            )
            
            
            (3,951,449
            )Other
      income (expense):Income
      from change in fair value of derivative liabilities
            
            
            -
            
            
            
            620,163
            
            
            
            169,241Interest
      expense
            
            
            (67,570
            )
            
            
            (245,877
            )
            
            
            (1,456,527
            )Interest
      income
            
            
            -
            
            
            
            2,263
            
            
            
            7,978Gain
      on sale of fixed assets
            
            
            1,329
            
            
            
            -
            
            
            
            3,847Other
      income (expense)
            
            
            -
            
            
            
            (1,790
            )
            
            
            49,790Total
      other income (expense)
            
            
            (66,241
            )
            
            
            374,759
            
            
            
            (1,225,671
            )Income
      (loss) before  taxes
            
            
            (278,859
            )
            
            
            54,687
            
            
            
            (5,177,120
            )Provision
      for taxes
            
            
            -
            
            
            
            -
            
            
            
            -Net
      income (loss)
            
            $
            (278,859
            )
            
            $
            54,687
            
            
            $
            (5,177,120
            )Undeclared
      preferred stock dividends
            
            
            (4,500
            )
            
            
            (4,500
            )
            
            
            (36,000
            )Loss
      applicable to common stockholders
            
            $
            (283,359
            )
            
            $
            50,187
            
            
            $
            (5,213,120
            )Net
      loss per share - basic
            
            $
            0.00
            
            
            $
            0.00
            
            
            $
            (0.07
            )Net
      loss per share - diluted
            
            $
            0.00
            
            
            $
            0.00
            
            
            $
            (0.07
            )Weighted
      average shares outstanding -basic
            
            
            101,637,276
            
            
            
            72,846,566
            
            
            
            77,898,660Weighted
      average shares outstanding -diluted
            
            
            101,637,276
            
            
            
            106,139,423
            
            
            
            77,898,660





The
accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.






F-2
 Table of Contents





INNOVATIVESOFTWARE TECHNOLOGIES, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(A
Development Stage Company)


(Unaudited)





For
      the Three
            
            
            For
      the Three
            
            
            CumulativeMonths
      Ended
            
            
            Months
      Ended
            
            
            from
      InceptionJune
      30,
            
            
            June
      30,
            
            
            (January
      12, 2005) to2008
            
            
            2007
            
            
            June
      30, 2008Net
      loss
            
            $
            (278,859
            )
            
            $
            54,688
            
            
            $
            (5,177,120
            )Adjustments
      to reconcile net loss to netcash
      provided by (used in) operating activities:Depreciation
      and amortization
            
            
            23,458
            
            
            
            2,115
            
            
            
            156,592Common
      stock and stock option based compensation
            
            
            75,925
            
            
            
            22,989
            
            
            
            1,032,602Notes
      payable issued for expenses paid by affiliates and third
      parties
            
            
            -
            
            
            
            -
            
            
            
            258,605Amortization
      of deferred gain on sale of assets
            
            
            (1,329
            )
            
            
            -
            
            
            
            2,673Services
      paid in common stock
            
            
            -
            
            
            
            -
            
            
            
            126,560Amortization
      of convertible debt discount
            
            
            33,608
            
            
            
            146,676
            
            
            
            1,022,286Change
      in fair value of derivative liabilities
            
            
            -
            
            
            
            (620,163
            )
            
            
            (169,241
            )Amortization
      of deferred financing costs
            
            
            -
            
            
            
            21,833
            
            
            
            232,199Net
      change in operating assets and liabilities:Accounts
      receivable
            
            
            8,450
            
            
            
            (10,410
            )
            
            
            -Prepaid
      expenses and other current assets
            
            
            -
            
            
            
            4,950
            
            
            
            9,961Deposits
            
            
            -
            
            
            
            19,557
            
            
            
            (1,400
            )Accounts
      payable and accrued expenses
            
            
            100,676
            
            
            
            101,874
            
            
            
            307,772Deferred
      revenue
            
            
            57,779
            
            
            
            -
            
            
            
            170,560Net
      cash used in operating activities
            
            
            19,708
            
            
            
            (255,891
            )
            
            
            (2,027,951
            )Cash
      flows from investing activities:Purchase
      of property and equipment
            
            
            (8,985
            )
            
            
            (19,260
            )
            
            
            (234,083
            )Proceeds
      from sale-leaseback of property and equipment
            
            
            -
            
            
            
            -
            
            
            
            125,000Increase
      in deferred financing costs
            
            
            -
            
            
            
            -
            
            
            
            (156,200
            )Net
      cash used in investing activities
            
            
            (8,985
            )
            
            
            (19,260
            )
            
            
            (265,283
            )Cash
      flows from financing activities:Stock
      issued for cash
            
            
            -
            
            
            
            -
            
            
            
            113,000Proceeds
      from notes payable
            
            
            -
            
            
            
            -
            
            
            
            427,969Proceeds
      from advances payable
            
            
            50,000
            
            
            
            -
            
            
            
            205,511Principal
      payments on notes payable
            
            
            -
            
            
            
            -
            
            
            
            (30,000
            )Proceeds
      from convertible debentures
            
            
            -
            
            
            
            -
            
            
            
            1,663,500Principal
      payments under capital lease
            
            
            (13,661
            )
            
            
            (8,686
            )
            
            
            (61,707
            )Cash
      acquired in the reverse acquisition of Innovative
            
            
            -
            
            
            
            -
            
            
            
            51,149Net
      cash provided by (used in) financing activities
            
            
            36,339
            
            
            
            (8,686
            )
            
            
            2,369,422Net
      increase (decrease) in cash and cash equivalents
            
            
            47,062
            
            
            
            (283,837
            )
            
            
            76,188Cash
      and cash equivalents at beginning of period
            
            
            29,126
            
            
            
            440,648
            
            
            
            -Cash
      and cash equivalents at end of period
            
            $
            76,188
            
            
            $
            156,811
            
            
            $
            76,188Supplemental
      disclosures of cash flow information:Cash
      paid during the period for:Interest
            
            $
            -
            
            
            $
            -
            
            
            $
            34,100Taxes
            
            $
            -
            
            
            $
            -
            
            
            $
            -Issuance
      of common stock for acquisition
            
            $
            -
            
            
            $
            -
            
            
            $
            440,000Issuance
      of common stock in exchange for debt
            
            $
            -
            
            
            $
            -
            
            
            $
            1,114,602Assets
      acquired under capital lease
            
            $
            -
            
            
            $
            -
            
            
            $
            136,512Fixed
      assets exchanged for lease payment
            
            $
            -
            
            
            $
            -
            
            
            $
            2,490Issuance
      of common stock to retire notes payable - affiliate
            
            $
            -
            
            
            $
            -
            
            
            $
            22,337Charge
      warrants and embedded derivative liabilitiesto
      additional paid-in capital
            
            $
            -
            
            
            $
            -
            
            
            $
            1,952,451Convertible
      debt issued for financing costs
            
            $
            -
            
            
            $
            -
            
            
            $
            44,000Issuance
      of shares to officer for accrued payroll
            
            $
            66,500
            
            
            $
            -
            
            
            $
            127,000





The
accompanying notes are an integral part of these unaudited
condensed consolidated financial statements.




F-3
 Table of Contents




INNOVATIVESOFTWARE TECHNOLOGIES, INC.


(A
DEVELOPMENT STAGE COMPANY)


UNAUDITED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





1. BASIS
OF PRESENTATION AND REPORTING





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
(GAAP) for interim financial information and with the instructions to Form 10-Q.
Accordingly, they do not contain all of the information and footnotes required
by GAAP for complete consolidated financial statements. In the opinion of
management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments (consisting only of normal recurring
adjustments) considered necessary for a fair presentation of the Company’s
financial condition as of June 30, 2008, and the results of its operations for
the three  months ended June 30, 2008, and June 30, 2007, and the cash
flows for the three months ended June 30, 2008, and June 30, 2007. These
unaudited condensed consolidated financial statements should be read in
conjunction with the Company's audited 2008 consolidated financial statements,
including the notes thereto, and the other information set forth therein,
included in the Company's Annual Report on Form 10-KSB for the year ended March
31, 2008. Operating results for the three month period ended June 30, 2008, are
not necessarily indicative of the operating results that may be expected for the
year ending March 31, 2009.





On June
26, 2006, Innovative Software Technologies, Inc., (“Innovative”), completed the
acquisition of AcXess, Inc., a Florida corporation (“AcXess”), in a stock
exchange transaction. As a result of the Transaction, AcXess became a wholly
owned subsidiary of Innovative.




On
November 28, 2007 the  (“Effective Date”) Innovative Software
Technologies, Inc., (“Innovative Software – CA”), entered into an Agreement and
Plan of Merger (the “Merger Agreement”) with Innovative Software
Technologies, Inc., a Delaware entity (“Innovative Software-DE”). Pursuant to
the Merger Agreement, Innovative Software-CA and Innovative Software-DE were
merged with and into the surviving corporation, Innovative Software-DE,
(“Innovative”, or  the “Company.”).   As of the
Effective Date, the certificate of incorporation and bylaws of the surviving
corporation became the certificate of incorporation and bylaws of the Company,
and the directors and officers in office of the surviving corporation became the
members of the board of directors and officers of the Company. Following the
execution of the Merger Agreement, on July 9, 2007 the Company filed with the
Secretary of State of Delaware a Certificate of Merger with respect to the
Innovative Software-CA and Innovative Software - DE merger.




The
accompanying unaudited consolidated financial statements present the accounts of
Innovative and its wholly owned subsidiaries, AcXess, Inc., and EPMG, Inc.
(collectively, the “Company”). All intercompany balances and significant
transactions have been eliminated.




The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. However, the Company has incurred a loss of
$5,177,120 from inception (January 12, 2005) through June 30, 2008, and has a
working capital deficiency and stockholder deficit of $1,443,907 and $1,341,493,
respectively,  at June 30, 2008. The Company currently has minimal
revenue generating operations and expects to incur substantial operating
expenses in order to expand its business. The Company expects to incur operating
losses for the foreseeable future.





Management
intends to continue to finance operations through fundraising activities as well
as to seek potential acquisitions that have positive cash flows; however, there
can be no assurance of successful fundraising or acquisition activity in the
future.





On July
24, 2007, the Company entered into a Stock Purchase Agreement (the “Agreement”)
with AcXess, Inc., its wholly owned subsidiary,  Thomas Elowson,
President of AcXess, Raymond Leitz, Chief Technical Officer of AcXess, and Helge
Solberg, Chief Architect of AcXess,  (collectively, Elowson, Leitz,
and Solberg referred to herein as the “Buyers”) wherein (i) AcXess redeemed
shares of its common stock from the Company in return for the issuance of a
promissory note to the benefit of the Company and the signing of a Non-Exclusive
License Agreement with the Company, and (ii) the Buyers exchanged stock of the
Company held by them  in exchange for stock in AcXess and Elowson
canceled options for stock in the Company held by him in exchange for stock in
AcXess.  Immediately following the above redemptions and exchanges,
the Company will continue to own 984,457 shares, or approximately 21.9% of the
outstanding common stock, of AcXess.  The transactions contemplated by
the Agreement  are expected to close upon approval of the transactions
by the Company’s shareholders.  AcXess has 4,500,000 shares of common
stock outstanding.  The Company has determined that it is in its best
interests to close this transaction after acquiring another operating
entity; however, there can be no assurance that the Company will be
successful in negotiating an agreement to acquire another operating entity nor
can there be any assurance that the Company, should it successfully negotiate an
agreement to acquire another operating entity, will be successful in closing
such a transaction. Please refer to the Company’s current report on Form 8-K as
filed with the Securities and Exchange Commission on July 30, 2007.






F-4
 Table of Contents




2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES




Use of
Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reported periods. Actual results could materially differ from those
estimates.





Cash and Cash
Equivalents





For
purposes of the statement of cash flows, cash equivalents include all highly
liquid debt instruments with original maturities of three months or less which
are not securing any corporate obligations.





Long-lived
Assets





The
Company accounts for its long-lived assets under the provision of Statements of
Financial Accounting Standards No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets”. The Company's long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. Events relating to
recoverability may include significant unfavorable changes in business
conditions, recurring losses, or a forecasted Inability to achieve break-even
operating results over an extended period. The Company evaluates the
recoverability of long-lived assets based upon forecasted undiscounted cash
flows. Should an impairment in value be indicated, the carrying value of
intangible assets will be adjusted, based on estimates of future discounted cash
flows resulting from the use and ultimate disposition of the asset.





Revenue
Recognition





The
Company  recognizes  revenues from  contracts in
which the Company  provides  website hosting and consulting
services as the services are performed. The contractual terms of
the  agreements  dictate
the  recognition  of revenue by
the  Company.  Payments received in advance are deferred
until the service is provided.





Contract
costs include all direct equipment, material, and labor costs and those indirect
costs related to contract performance, such as indirect labor. Selling, general
and administrative costs are charged to expense as incurred. Provisions for
estimated losses on uncompleted contracts are made in the period in which such
losses are determined. Changes in contract performance, contract conditions, and
estimated profitability that may result in revisions to costs and income are
recognized in the period in which the revisions are determined.




For
revenue from product sales, the Company recognizes revenue in accordance with
Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which
superseded SAB No. 101, “Revenue Recognition in Financial Statements.” SAB No.
104 requires that four basic criteria must be met before revenue can be
recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has
occurred; (3) the selling price is fixed and determinable; and (4)
collectibility is reasonably assured. Determination of criteria (3) and (4) are
based on management’s judgments regarding the fixed nature of the selling prices
of the products delivered and the collectibility of those amounts. Provisions
for discounts and rebates to customers, estimated returns and allowances, and
other adjustments are provided for in the same period the related sales are
recorded. The Company defers any revenue for which the product has not been
delivered or is subject to refund until such time that the Company and the
customer jointly determine that the product has been delivered or no refund will
be required. SAB No.
104  incorporates  Emerging  Issues Task
Force  (“EITF”) No. 00-21, “Multiple-Deliverable Revenue
Arrangements.” EITF No. 00-21 addresses accounting for arrangements that may
involve the delivery or performance of multiple products, services and/or rights
to use assets. This issue addresses determination of whether an arrangement
involving more than one deliverable contains more than one unit of accounting
and how the arrangement consideration should be measured and allocated to the
separate units of accounting.  Through June 30, 2008, all of the
Company’s revenue has been service revenue.





Offering
Costs





Direct
costs of an equity offering are charged to additional paid-in capital upon
closing of the offering and receipt of funds.





Income
Taxes





The
Company has implemented the provisions on Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires
that income tax accounts be computed using the liability method. Deferred taxes
are determined based upon the estimated future tax effects of differences
between the financial reporting and tax reporting bases of assets and
liabilities given the provisions of currently enacted tax laws.





F-5
 Table of Contents




Fair Value of Financial
Instruments





The
Company measures its financial assets and liabilities in accordance with
accounting principles generally accepted in the United States of America. The
estimated fair values approximate their carrying value because of the short-term
maturity of these instruments or the stated interest rates are indicative of
market interest rates.




Stock Based
Compensation




Effective
January 1, 2006, the Company adopted SFAS No. 123 (revised) (“SFAS No.
123(R)”), “Share Based
Payment,” (SFAS 123(R)) which eliminates the use of APB Opinion
No. 25 and require the Company to measure the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award. That cost will be recognized over the period
during which an employee is required to provide service in exchange for the
reward—known as the requisite service period. No compensation cost is recognized
for equity instruments for which employees do not render the requisite service.
The grant-date fair value of employee share options and similar instruments will
be estimated using option-pricing models adjusted for the unique characteristics
of those instruments.


(a) Loss
per Common Share




The
Company calculates net income (loss) per share as required by Statement of
Financial Accounting Standards (SFAS) 128, "Earnings per Share." Basic earnings
(loss) per share is calculated by dividing net income (loss) by the weighted
average number of common shares outstanding for the period. Diluted earnings
(loss) per share is calculated by dividing net income (loss) by the weighted
average number of common shares and dilutive common stock equivalents
outstanding during periods when anti-dilutive common stock equivalents are not
considered in the computation.




Basic
loss per share is based on the weighted effect of common shares issued and
outstanding, and is calculated by dividing net loss by the weighted average
shares outstanding during the period. Diluted loss per share is calculated by
dividing net loss by the weighted average number of common shares used in the
basic loss per share calculation plus the number of common shares that would be
issued assuming exercise or conversion of all potentially dilutive common shares
outstanding.




(b) Customer
Concentration




During
the three months ended June 30, 2008 and 2007, two customers accounted for
approximately 73% and 98% of revenues, respectively. The loss of these customers
would have a material adverse effect on financial results.




F-6
 Table of Contents




Recent Accounting
Developments:




In
March 2008, the Financial Accounting Standards Board issued SFAS
No. 161, Disclosures about Derivative Instruments and Hedging Activities —
an Amendment of Statement No. 133 (SFAS 161). SFAS 161 enhances disclosure
requirements about (a) how and why an entity uses derivative instruments,
(b) how derivative instruments and related hedged items are accounted for
under SFAS No. 133 and its related interpretations, and (c) how
derivative instruments and related hedged items affect an entity’s financial
position, financial performance and cash flows. This statement is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application encouraged. The Company is
currently evaluating the impact of adoption of SFAS 161.




In
May 2008, the FASB issued Staff Position (FSP) EITF 03-6-1,
Determining Whether Instruments Granted in Share-Based Payment Transactions are
Participating Securities. This staff position addresses whether instruments
granted in share-based payment transactions are participating securities prior
to vesting and, therefore, need to be included in the allocation in computing
earnings per share under the two-class method described in SFAS 128, Earnings
Per Share. The FASB concluded that all outstanding unvested share-based payment
awards that contain rights to nonforfeitable dividends participate in
undistributed earnings with common shareholders. If awards are considered
participating securities, the Company is required to apply the two-class method
of computing basic and diluted earnings per share. FSP EITF 03-6-1 is effective
for fiscal years beginning after December 15, 2008 and interim periods
within those fiscal years. Early adoption is prohibited. The Company is
currently evaluating the impact of adoption of this guidance.




In
November 2007, FASB issued EITF 07-1, “Accounting for Collaborative
Arrangements" (“EITF 07-1”).”   EITF 07-1 requires additional disclosures
related to collaborative arrangements. EITF 07-1 is effective for fiscal years
beginning after December 15, 2008.  The Company is currently assessing
the impact the adoption of EITF 07-1 will have on the Company’s consolidated
financial statements.




In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business
Combinations - Revised 2007. SFAS 141 R provides guidance on improving the
relevance, representational faithfulness, and comparability of information that
a reporting entity provides in its financial reports about a business
combination and its effects. SFAS 141R applies to business combinations where is
the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. The Company is in the process of
analyzing the effects SFAS 141R will have on the Company’s financial
statements.




In
December 2007, the FASB also issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements, which establishes accounting and reporting
standards to improve the relevance, comparability, and transparency of financial
information in its consolidated financial statements that include an outstanding
noncontrolling interest in one or more subsidiaries. SFAS 160 is effective for
fiscal years, and the interim periods within those fiscal years, beginning on or
after December 15, 2008. Management of the Company does not expect the adoption
of this pronouncement to have a material impact on its financial
statements.




In
May 2008, the FASB released SFAS No. 162, “The Hierarchy of Generally
Accepted Accounting Principles.”   SFAS No. 162 identifies the sources
of accounting principles and the framework for selecting the principles used in
the preparation of financial statements of nongovernmental entities that
presented in conformity with generally accepted accounting principles in the
United States of America. SFAS No. 162 will be effective 60 days following the
SEC’s approval of the PCAOB amendments to AU Section 411, The Meaning of Present
Fairly in Conformity With Generally Accepted Accounting Principles.  The
Company does not believe SFAS 162 will have a significant impact on the
Company’s consolidated financial statements.




Recently adopted accounting
pronouncements




Effective
at the beginning of the first quarter of 2009, the Company adopted the provision
of FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of
FASB Statement No. 109” (“FIN 48”).  FIN 48 contains a two-step
approach to recognizing and measuring uncertain tax positions accounted for in
accordance with SFAS No. 109, “Accounting for Income Taxes.”  The
first step is to evaluate the tax position for recognition by determining if the
weight of available evidence indicates that it is more likely than not that the
position will be sustained on audit, including resolution of related appeals or
litigation processes, if any.  The second step is to measure the tax
benefit as the largest amount that is more than 50% likely of being realized
upon ultimate settlement.




As a
result of the implementation of FIN 48, the Company has not changed any of its
tax accrual estimates.  The Company files U.S. federal and U.S. state
tax returns.  For state tax returns the Company is generally no longer
subject to tax examinations for years prior to 1996.




Effective
April 1, 2008, the Company partially adopted SFAS 157, which provides a
framework for measuring fair value. Fair value is defined as the price that
would be received for an asset or paid to transfer a liability (an exit price)
in the principal or most advantageous market for the asset or liability in an
orderly transaction between market participants at the measurement date. The
partial adoption of this standard only resulted in additional disclosure
requirements and had no financial statement impact. Delayed application of this
statement is permitted for nonfinancial assets and nonfinancial liabilities,
except for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until fiscal years
beginning after November 15, 2008, and interim periods within those fiscal
years. The Company has not applied the provisions of SFAS 157 for intangible
assets and long-lived assets measured for fair value for impairment assessment
under Statement 144, Accounting for the Impairment or Disposal of Long-Lived
Assets.




Effective
April 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for
Financial Assets and Liabilities — Including an Amendment of SFAS No. 115
(SFAS 159). This standard permits an entity to choose to measure many financial
instruments and certain other items at fair value. Most of the provisions in
SFAS No. 159 are elective; however, the amendment to SFAS No. 115,
Accounting for Certain Investments in Debt and Equity Securities, applies to all
entities with available-for-sale and trading securities. The fair value option
established by SFAS 159 permits the Company to choose to measure eligible items
at fair value at specified election dates. The Company will report unrealized
gains and losses on items for which the fair value option has been elected in
earnings at each subsequent reporting date. The fair value option: (a) may
be applied instrument by instrument, with a few exceptions, such as
investments  otherwise accounted for by the equity method; (b) is
irrevocable (unless a new election date occurs); and (c) is applied only to
entire instruments and not to portions of instruments. In connection with the
adoption of this standard, the Company did not elect any additional financial
instruments to be recorded at fair value.






F-7
 Table of Contents




3.  ADVANCES
PAYABLE





Advances
payable of $50,000 at June 30, 2008 consist of  cash advances to the
Company by Aspen Capital and a shareholder, Peter Peterson. These cash advances
will accrue interest at a rate of 10% per annum.  During the three
months ended June 30, 2008, we accrued interest in the amount of $208 for these
cash advances.





During
the three months ended June 30, 2008, the Company converted a cash advance of
$155,511 and capitalized interest in the amount of $2,568, into a promissory
note payable in the amount of $158,079 to Xalles, an Irish corporation
(“Xalles”).  The Company has been involved in negotiations to purchase
Xalles.  These funds were advanced to the Company by Xalles for the
purpose of general working capital and trade payables of both Xalles and the
Company.





4.
PROPERTY AND EQUIPMENT





Property
and equipment consist of the following as of June 30, 2008 and March 31,
2008:





June
      30, 2008
            
            
            March
      31, 2008Equipment
            
            $
            77,567
            
            
            $
            68,583Computer
      software
            
            
            4,930
            
            
            
            4,930Furniture
      and fixtures
            
            
            1,258
            
            
            
            1,258Property
      and equipment under capital lease
            
            
            134,022
            
            
            
            134,022217,777
            
            
            
            208,793Accumulated
      depreciation and amortization
            
            
            (117,763
            )
            
            
            (94,306
            )$
            100,014
            
            
            $
            114,487





Depreciation
expense was $23,458 and $2,115 for the three month ended June 30, 2008 and 2007,
respectively.





5.  DEFERRED
REVENUE





The
Company’s wholly-owned subsidiary AcXess, Inc.  receives payment in
advance for certain of its services, primarily website hosting.  These
payments are recognized as revenue over the period for which the services is
provided.  As of June 30, 2008 and March 31, 2008, these advance
payments aggregated a total of $170,560 and $112,781, respectively; this amount
will be taken into revenue over the following twelve months.





6.  CONVERTIBLE
NOTES AND DERIVATIVE LIABILITIES




Derivative
Financial Instruments




The
Company does not use derivative instruments to hedge exposures to cash flow,
market, or foreign currency risks.




The
Company reviews the terms of convertible debt and equity instruments issued to
determine whether there are embedded derivative instruments, including the
embedded conversion option, that are required to be bifurcated and accounted for
separately as a derivative financial instrument. In circumstances where the
convertible instrument contains more than one embedded derivative instrument,
including the conversion option, that is required to be bifurcated, the
bifurcated derivative instruments are accounted for as a single, compound
derivative instrument. Also, in connection with the sale of convertible debt and
equity instruments, the Company may issue freestanding options or warrants that
may, depending on their terms, be accounted for as derivative instrument
liabilities, rather than as equity. The Company may also issue options or
warrants to non-employees in connection with consulting or other services they
provide.




F-8
 Table of Contents




Certain
instruments, including convertible debt and equity instruments and the
freestanding options and warrants issued in connection with those convertible
instruments, may be subject to registration rights agreements which impose
penalties for failure to register the underlying common stock by a defined date.
These penalties are measured and accrued in accordance with Statement of
Financial Accounting Standards No. 5, “Accounting for
Contingencies”.  When the ability to physical or net-share settle the
conversion option or the exercise of the freestanding options or warrants is
deemed to be not within the control of the Company, the embedded conversion
option or freestanding options or warrants may be required to be accounted for
as a derivative instrument liability.




Derivative
financial instruments are initially measured at their fair value. For derivative
financial instruments that are accounted for as liabilities, the derivative
instrument is initially recorded at its fair value and is then re-valued at each
reporting date, with changes in the fair value reported as charges or credits to
income. For option-based derivative financial instruments, the Company uses the
Black-Scholes option pricing model to value the derivative
instruments.




When
freestanding options or warrants are issued in connection with the issuance of
convertible debt or equity instruments and will be accounted for as derivative
instrument liabilities (rather than as equity), the total proceeds received are
first allocated to the fair value of those freestanding instruments. When the
freestanding options or warrants are to be accounted for as equity instruments,
the proceeds are allocated between the convertible instrument and those
derivative equity instruments, based on their relative fair values. When the
convertible debt or equity instruments contain embedded derivative instruments
that are to be bifurcated and accounted for as liabilities, the total proceeds
allocated to the convertible host instruments are first allocated to the fair
value of all the bifurcated derivative instruments. The remaining proceeds, if
any, are then allocated to the convertible instruments themselves, usually
resulting in those instruments being recorded at a discount from their face
amount.




To
the extent that the fair values of the freestanding and/or bifurcated derivative
instrument liabilities exceed the total proceeds received, an immediate charge
to income is recognized, in order to initially record the derivative instrument
liabilities at their fair value.




The
discount from the face value of the convertible debt, together with the stated
interest on the instrument, is amortized over the life of the instrument through
periodic charges to income, usually using the effective interest method. When
the instrument is convertible preferred stock, the dividends payable are
recognized as they accrue and, together with the periodic amortization of the
discount, are charged directly to retained earnings.




The
classification of derivative instruments, including whether such instruments
should be recorded as liabilities or as equity, is re-assessed periodically,
including at the end of each reporting period. If re-classification is required,
the fair value of the derivative instrument, as of the determination date, is
re-classified. Any previous charges or credits to income for changes in the fair
value of the derivative instrument are not reversed. Derivative instrument
liabilities are classified in the balance sheet as current or non-current based
on whether or not net-cash settlement of the derivative instrument could be
required within twelve months of the balance sheet date.  During the
year ended March 31, 2008, due to the conversion of the Convertible Notes
Payable to common stock (see below), the Company reclassified derivative
liabilities in the amount of $993,015  from liability to
equity.




In
January 2006 the Board of Directors of the Company approved the raising of up to
$1,000,000 via the issuance of promissory notes (the “Notes”) to accredited
investors. These notes have a term of six months, an interest rate of 12% per
annum, and are convertible into shares of common stock of the Company at a 30%
discount to a future Qualified Financing (as therein described). As a result of
this, the Company could ultimately issue an unlimited number of shares of common
stock.  This resulted in liability treatment for all of the related
derivatives. In addition, each of the Notes is issued with warrants to purchase
Company common stock at a strike price of $0.05 per share. The number of
warrants granted is determined by multiplying the face value of each note issued
by four. In October the Board of Directors of the Company approved an increase
in the amount to be raised under this financing to $1,500,000. A total of
$1,107,500 had been raised as of November 10, 2006, when the Company closed the
round. During the three and nine months ended June 30, 2008, the Company was in
default on all Notes totaling a principal amount of $1,107,500. In the event of
a default resulting from the Company's non-payment of principal or interest when
due, a holder of the Notes may declare all unpaid principal and accrued interest
due and payable immediately. The Company was served a complaint from one
investor demanding repayment of $55,000 under one of the Notes.  The
Company reached a settlement agreement with this investor, and executed a mutual
release and the complaint was dismissed on October 25, 2007  (see Note
9). No notice has been received from any other holder of the Notes and the
Company is currently in the process of renegotiating the terms of the Notes (as
noted below); however there can be no assurance that such negotiations will be
successful.





On
December 22, 2006, the Company entered into a securities purchase agreement with
an accredited investor (the “Investor”) for the sale of $1,000,000 Convertible
Debentures (the “Debentures”). In connection with the Agreement, the Investor
received (i) a warrant to purchase 8,928,571 shares of common stock (“Long-Term
Warrants”) exercisable at $0.30 and (ii) a warrant to purchase 1,785,714 shares
of common stock (“Short Term Warrants”) exercisable at $0.143 per share. The
Long Term Warrants and the Short Term Warrants are exercisable for a period four
years from the date of issuance and the earlier of (i) December 22, 2007 and
(ii) the date a registration statement(s) covering the resale of all Registrable
Securities (as defined in the Registration Rights Agreement) is declared
effective by the SEC (the “Initial Exercise Date”) and on or prior to the close
of business on the four month anniversary of the Initial Exercise Date,
respectively. The Company incurred approximately $81,140 in interest expense
relating to the Debentures due to the “Liquidating Damages” clause specified in
the Purchase Agreement as a registration statement covering the Registrable
Securities was declared effective by the SEC on July 23, 2007, 123 days after
the agreed upon date in the Purchase Agreement, March 23, 2007.  The
penalty is calculated as 2% per 30 day period or partial 30 day period beyond
the dates stipulated above.  The maximum aggregate liquidated damages
payable to a Holder under this Agreement is 10.5% of the aggregate subscription
amount paid by such Holder pursuant to the Purchase Agreement. Pursuant to
Emerging Issues Task Force issue No. 00-19, “Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”,
there are no gains or losses associated with this penalty, as it is not indexed
to or settled in the stock of the Company.




F-9
 Table of Contents




The
default on the Notes discussed above is an “Event of Default” in accordance with
the terms of the Debenture and, therefore, the Debenture holder may declare all
principal and interest due and payable immediately; however, the Company has
received no notice from the Debenture holder demanding such
repayment.




The
Debentures bear interest at 4% until June 22, 2007 and 9% thereafter, payable in
arrears and mature three years from the date of issuance. Accrued interest is
payable in cash semi-annually, beginning on July 1, 2007. The Company has not
made the interest payment of $22,438 due on July 1, 2007 and intends to
negotiate a settlement with the Debenture holder; however there can be no
assurance that such negotiation will be successful





Warrants
were initially accounted for as derivative instrument liabilities (see below) in
accordance with EITF 00-19, "Accounting for Derivative Financial Instruments
Indexed To, and Potentially Settled In, a Company's Own Common Stock" (“EITF
00-19”) primarily as a result of the possible conversion of other debt into a
possible unlimited number of shares. Accordingly, the initial fair values of the
warrants, amounting to an aggregate of $82,239 relating to the issuance of the
Notes, and $964,286 relating to the issuance of the Debentures, were recorded as
a derivative instrument liability. The fair value of the warrants was determined
using the Black-Scholes valuation model, based on the market price of the common
stock on the dates the warrants were issued, an expected dividend yield of 0%, a
risk-free interest rate based on constant maturity rates published by the U.S.
Federal Reserve, applicable to the life of the warrants, expected volatility of
114% (based on analysis of historical stock prices of the Company and its
selected peers), and the five year and four year life of the warrants relating
to the Notes and Debentures, respectively. The Company is required to re-measure
the fair value of the warrants at each reporting period.




Because
the conversion price of the Notes is not fixed, they are not “conventional
convertible debt” as that term is used in EITF 00-19 primarily as a result of
the possible conversion of other debt into a possible unlimited number of
shares. Accordingly, the Company is required to bifurcate and account separately
for the embedded conversion options, together with any other derivative
instruments embedded in the Notes. The Debentures are a hybrid instrument that
embodies several derivative features. The instrument is not afforded the
“conventional” convertible exemption because of certain full-ratchet
anti-dilution protections afforded the investors. Further, certain derivative
features did not meet the conditions for equity classification set forth in EITF
00-19. As a result, the Company has combined all embedded derivatives into one
compound derivative financial instrument for financial accounting and
reporting.




The
freestanding warrants issued with the Debentures are also hybrid instruments
that embody derivative features. While bifurcation of the embedded derivatives
was not required, the warrants did not otherwise meet all of the conditions for
equity classification set forth in EITF 00-19. As a result, the Company has
recorded the warrants as derivative liabilities at fair value.




The
conversion option related to each of the Notes was bifurcated from the Note and
accounted for separately as a derivative instrument liability (see below). The
bifurcated embedded derivative instruments, including the embedded conversion
options which were valued using the Flexible Monte Carlo Simulation methodology,
were recorded at their initial fair value of an aggregate of
$801,911.





The
discount from the face amount of the Notes represented by the value assigned to
the warrants and bifurcated derivative instruments is being amortized over the
period to the due date of each of the Notes, using the effective interest
method. Amortization related to the Notes for the three months ended June 30,
2008 and 2007 was $0 and $139,622.




On August
23, 2007, the Company issued an aggregate of 5,672,655 shares of common stock in
exchange for the conversion of the Notes with the principal amount of $263,315
and accrued interest of $20,318 totaling $283,633, based on a conversion price
of $0.05 per share. This transaction was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933. The balance of the Notes at
September 30, 2007 was $902,722. During the three months ended December 31,
2007, the Company also converted the following Notes:  on October 12,
2007, the Company issued 14,633,759 shares of its common stock in exchange for
the conversion of convertible promissory notes and accrued interest therein in
the aggregate amount of $731,688, based on a conversion price of $0.05 per
share; On October 19, 2007, the Company issued 574,630 shares of its common
stock in exchange for the conversion of convertible promissory notes and accrued
interest therein in the aggregate amount of $28,732, based on a conversion price
of $0.05 per share; and on December 17, 2007, the Company issued 3,581,314
shares of its common stock in exchange for the conversion of convertible
promissory notes and accrued interest therein in the aggregate amount of
$179,066, based on a conversion price of $0.05 per share.  These
transactions were exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933.  At December 31, 2007, all of the Notes had
been converted and none remain outstanding.  At the time of the
conversions, the Company reclassified the outstanding derivative
liabilities at the time of the conversions in the aggregate amount
of  $993,015 related to the Convertible Promissory Notes to additional
paid-in capital during the year ended March 31, 2008.




As a
result of this conversion, all outstanding warrants and embedded derivative
liabilities were recharacterized as equity and reclassified to additional
paid-in capital.




The
conversion option related to the Debentures was bifurcated from the Debentures
and accounted for separately as a derivative instrument liability (see below).
The bifurcated embedded derivative instruments, including the embedded
conversion option which was valued using the Flexible Monte Carlo Simulation
methodology, was recorded at its initial fair value of an aggregate of
$553,466.




The
discount from the face amount of the Debentures represented by the value
assigned to the warrants and bifurcated derivative instruments is being
amortized over the period to the due date of the Debentures, using the effective
interest method. Amortization related to the Debentures for the three months
ended June 30, 2008 and 2007, was $33,609 and $7,054, respectively.





F-10
 Table of Contents




A summary
of the Debentures and unamortized discount  at June 30 and March 31,
2008 , is as follows:




June
      30,
            
            
            March
      31,2008
            
            
            2008Debenture;
      4% per annum (increased to 9%per
      annum in July 2007); due December 22, 2009
            
            $
            1,000,000
            
            
            $
            1,000,000Less:
      Unamortized discount
            
            
            (895,997
            )
            
            
            (929,606
            )Net
      carrying value
            
            $
            104,003
            
            
            $
            70,394





The
Registration Rights Agreement contains a “Liquidating Damages” provision,
whereby the Company is obligated to file a registration statement covering the
Registrable Securities within 60 days of the Purchase Agreement,  and
cause  such registration statement to become effective within 90 days
of the Purchase Agreement.  If either of these deadlines is
not  met, the Company incurs a penalty in the amount of 2% per month
of the aggregate purchase price of the securities.  The Company filed
such registration statement within the 60 day period, but the registration
statement did not become effective until 123 days after the Purchase Agreement,
and the Company incurred liquidated damages in the amount of $81,140. The
Purchase Agreement became effective on July 23, 2007, 123 days after the agreed
upon date in the Purchase Agreement, March 22, 2007.   This
penalty is payable in cash, and accordingly the provisions of and the amount of
$81,140 was charged to accrued liabilities on the Company’s balance sheet at
June 30, 2008 (see note  3).




7.  COMMON
STOCK





During
the three months ended June 30, 2008, the Company had the following common stock
issuances:





On May
30, 2008, the Company issued shares of common stock at a price of $0.05 per
shares for previously accrued salary in the amount of $31,500 to the Company’s
Chief Financial Officer.  A total of  630,000 shares of
common stock were issued to the officer.





On May
30, 2008, the Company issued shares of common stock at a price of $0.05 per
shares for previously accrued salary in the amount of $35,000 to the Company’s
Executive Officer.  A total of  700,000 shares of common
stock were issued to the officer.





Options





On August
9, 2006, the Company adopted the Innovative Software Technologies, Inc. 2006
Equity Incentive Plan (the "Plan"). An aggregate of 20 million shares of common
stock is authorized for issuance under the Plan. Options must terminate no later
than the tenth (10th) anniversary of the date of grant, and each incentive stock
option granted to any 10% Owner-Employee (as defined in the Plan) must terminate
no later than the fifth (5th) anniversary of the date of grant. The Company
accounts for stock-based compensation using the fair value method as defined in
SFAS 123(R) and estimates the fair value of each option grant on the grant date
using an option-pricing model.





On August
24, 2007, the Company adopted the Innovative Software Technologies, Inc. 2007
Equity Incentive Plan (the “2007 Plan”). An aggregate of 60 million shares of
common stock is authorized for issuance under the 2007 Plan. The Company
accounts for stock-based compensation using the fair value method as defined in
SFAS 123(R) and estimates the fair value of each option grant on the grant date
using an option-pricing model. During the three months ended June 30, 2008 and
2007 the Company recognized $75,925 and $22,989  in stock-based
compensation.





A summary
of the Company's stock option 2006 and 2007 Plans as of June 30, 2008 is
presented below:




Weighted
            
            
            Weighted
              average
            
            
            
            
            
            Weighted
              averageaverage
            
            
            exercise
            
            
            
            
            
            exerciseRange
      of
            
            
            Number
      of
            
            
            remaining
            
            
            price
      of
            
            
            Number
      of
            
            
            price
      ofexercise
            
            
            options
            
            
            contractual
            
            
            outstanding
            
            
            options
            
            
            exercisableprices
            
            
            outstanding
            
            
            life
      (years)
            
            
            options
            
            
            exercisable
            
            
            options$
            0.05
            
            
            
            28,500,000
            
            
            
            4.3
            
            
            $
            0.05
            
            
            
            11,718,750
            
            
            $
            0.05$
            0.08
            
            
            
            6,000,000
            
            
            
            3.6
            
            
            $
            0.08
            
            
            
            5,833,334
            
            
            $
            0.08$
            0.13
            
            
            
            250,000
            
            
            
            3.2
            
            
            $
            0.13
            
            
            
            250,000
            
            
            $
            0.13$
            0.14
            
            
            
            5,978,349
            
            
            
            3.1
            
            
            $
            0.14
            
            
            
            5,978,349
            
            
            $
            0.1440,728,349
            
            
            
            3.5
            
            
            $
            0.07
            
            
            
            23,780,433
            
            
            $
            0.08







F-11
 Table of Contents




Weighted
      AverageOptions
            
            
            Exercise
      PriceOutstanding
      at March 31, 2008
            
            
            40,887,349
            
            
            $
            0.08Issued
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -Forfeited
      or expired
            
            
            (159,000
            )
            
            
            0.11Outstanding
      at June 30, 2008
            
            
            40,728,349
            
            
            $
            0.08Non-vested
      at June 30, 2008
            
            
            16,947,916
            
            
            $
            0.05Exercisable
      at June 30, 2008
            
            
            23,780,433
            
            
            $
            0.08





Aggregate
intrinsic value of options outstanding and exercisable at June 30, 2008 was $0.
Aggregate intrinsic value represents the difference between the Company's
closing stock price on the last trading day of the fiscal period, which was
$0.02 as of June 30, 2008, and the exercise price multiplied by the number of
options outstanding. As of June 30, 2008, total unrecognized stock-based
compensation expense related to stock options was $376,050.




8.   RELATED
PARTY TRANSACTIONS





During
the three months ended  June 30, 2008, the Company had the following
transactions with related parties:





On May
30, 2008, the Company issued shares of common stock at a price of $0.05 per
shares for previously accrued salary in the amount of $31,500 to the Company’s
Chief Financial Officer.  A total of  630,000 shares of
common stock were issued to the officer.





On May
30, 2008, the Company issued shares of common stock at a price of $0.05 per
shares for previously accrued salary in the amount of $35,000 to the Company’s
Executive Officer.  A total of  700,000 shares of common
stock were issued to the officer.





The
Company accrued salary in the amount of $21,000 to the Company’s Chief executive
Officer.





The
Company accrued salary in the amount of $17,500 to the  Company’s
previous Chief Financial Officer, who resigned effective May 31,
2008.





The
Company accrued salary in the amount of $5,000 to the Company’s new Chief
Financial Officer, whose tenure with the Company began June 1, 2008.
..




9.  COMMITMENTS
AND CONTINGENCIES





(a)
Leases:




In
February 2007 the Company entered into a $500,000 Master Lease Line for
Equipment Purchases (the “Master Lease Agreement”). At that time, the Company
sold property and equipment for $125,000 and leased them back under the Master
Lease Agreement. The Company recognized a gain on the sale of those assets of
$10,633 which was deferred and will be recognized over the 24 month term of the
lease.  At June 30, 2008, the balance of this deferred gain was
$3,545.




The
Master Lease Agreement calls for draws of a minimum of $100,000, a minimum term
of 18 months and a maximum term of 36 months. The lease entered into in February
2007 has monthly payments of $6,363. The Company accounted for this lease as a
capital lease.




In
connection with the Master Lease Agreement, the Company agreed to issue five
year warrants to the lender to purchase 1,350,000 shares of the Company’s common
stock at an exercise price of $0.18 per share. Ten percent (135,000) of the
warrants vested upon execution of the Master Lease Agreement. The remaining 90%
of the warrants vest as on a pro rata basis as the lender provides funding under
the Master Lease Agreement. As such 303,750 warrants vested upon execution of
the sale lease-back described above. The total number of warrants, 438,750, was
valued using the Black-Scholes method and applied to the capital lease
obligation in accordance with Accounting Principles Board (“APB”) No. 14. This
resulted in a decrease in capital lease obligation of $37,726 and a
corresponding increase in additional paid-in capital.




Rent
expense under all operating leases for the three  months ended June
30, 2008 and 2007, was $2,700  and $17,550, respectively. As of July
1, 2007, our principal executive offices are located at 911 Ranch Road 620
North, Austin, Texas 78734. This office consists of approximately 340
square feet which we rent for $900 per month. The term of the lease is month to
month with a 60 day notice period.




F-12
 Table of Contents




(b) Litigation:




Kansas
City Explorers




The
Company is a defendant in a lawsuit in the Circuit Court of Platte County,
Missouri, “Kansas City Explorers vs. Innovative Software” Case no. 04CV82050 in
which the claimant is seeking money for advertising which it alleges is still
due, and have alleged damages of $50,028. The claimant has been court ordered to
produce answers to certain discovery requests of the Company which they have
failed to produce. Management intends to aggressively defend the claim based
upon the lack of contract between the parties, lack of proof of damages, as well
as minimal proof of advertising services actually performed for Company products
and services, and other legal and equitable defenses. The Company has not
accrued any amount for the contingency.




Bernard
F. Mathaisel




On June
14, 2007 the Company was served with a complaint from Bernard F. Mathaisel for
breach of contract relating to an alleged consulting agreement with the Company
and breach of contract alleging failure to repay a Note due him in the principal
amount of $55,000. On October 11, 2007, Mr. Mathaisel and the Company executed a
mutual release and the complaint was dismissed on October 25, 2007 following the
purchase of the Mathaisel note by another investor.




10.
SUBSEQUENT EVENTS





During
July 2008, the Company issued 1,000,000 shares of common stock to a service
provider to satisfy an accounts payable  of $20,000.




Item2. Management’s
Discussion and Analysis or Plan of Operations




The
information presented in this section should be read in conjunction with our
audited financial statements and related notes for the periods ended March 31,
2008 and 2007  included in our Form 10-KSB, filed July 15, 2008, as
well as the information contained in the financial statements, including the
notes thereto, appearing elsewhere in this report. This discussion contains
forward-looking statements reflecting our current expectations that involve
risks and uncertainties. Actual results and the timing of events may differ
materially from those contained in these forward-looking statements due to a
number of factors, including those discussed in the section entitled “Risk
Factors” and elsewhere in this report.





The following discussion includes
statements that are forward looking in nature. The accuracy of such statements
depends on a variety of factors that may affect the business and operations of
the Company. Certain of these factors are discussed under “Business - Factors
Influencing Future Results and Accuracy of Forward-Looking Statements” included
in Part 1 of this report. When used in this discussion, the words “expect(s)”,
“feel(s)”, “believe(s)”, “will”, “may”, “anticipate(s)” and similar expressions
are intended to identify forward-looking statements. Such statements are subject
to certain risks and uncertainties, and actual results could differ materially
from those projected. Readers are cautioned not to place undue reliance on these
forward-looking statements, and are urged to carefully review and consider the
various disclosures elsewhere in this Form 10-Q.




Overview





The
following discussion summarizes information about our accounting policies and
practices and information about our operations in a comparative manner for the
three months ended June 30, 2008, and 2007. Our management’s discussion and
analysis of financial condition and results of operations should be read in
conjunction with our consolidated financial statements and related notes thereto
included elsewhere herein.





Acquisition
of AcXess, Inc.




On June
26, 2006, we completed the acquisition of AcXess, Inc., a Florida corporation,
in a stock exchange transaction pursuant to a Stock Exchange Agreement by and
between us, AcXess, the Shareholders of AcXess, and Anthony F. Zalenski, acting
as the Shareholder's Agent (the "Exchange Agreement"). As a result of the
Transaction, AcXess became our wholly owned subsidiary. In accordance with the
provisions of Statements of Financial Accounting Standards No. 141 (“SFAS”)
“Business Combination (“SFAS 141”)”, AcXess was deemed to be the purchaser in
the transaction for financial reporting purposes.  For accounting
purposes, AcXess is treated as the continuing reporting entity and the inception
date of AcXess was January 12, 2005.






F-13
 Table of Contents




AcXess’
strategy was to provide Business Continuity (BC) and application hosting
services to the Small and Medium Enterprise (SME)  market. After
careful review the  Company determined that the capital requirements
and time to market for the products and services of AcXess were greater than
previously expected . As a result of this finding the Company entered into an
agreement on July 24, 2007 to sell approximately 78.1% of the common stock of
AcXess to the AcXess management team. In exchange for this sale the Company will
receive:




(1)
            A
      promissory note in the amount of $1,000,000. The note will have a term of
      two years and will bear interest at a rate of 10% per year. The note is
      collateralized with all assets of AcXess and has an acceleration clause
      for any material default.(2)
            A
      license agreement grant that gives the Company a non-exclusive worldwide
      right and license products under Axcess’ patents relating to Business
      Continuity (BC) solutions.





(3)
            The
      return of 4,477,292 shares of common stock and the cancellation
      of  fully vested options to purchase 5,978,349 shares of the
      Company’s common stock.




This
sale-transaction is expected to close upon the successful  completion
of a new acquisition by the Company.





Critical
Accounting Policies and Estimates





The
discussion and analysis of our financial condition and results of operations are
based upon the Company's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of these financial statements requires
us to make estimates and judgments that affect the reported amounts of assets
and liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities at the date of the Company's financial statements. Actual
results may differ from these estimates under different assumptions or
conditions.





Critical
accounting policies are defined as those that are reflective of significant
judgments and uncertainties, and potentially result in materially different
results under different assumptions and conditions. The Company’s critical
accounting policies are discussed in its annual report on Form 10-KSB for the
year ended March 31, 2008.





Results
of Operations





Three
months ended June 30, 2008, compared to the three months ended June 30,
2007.





Revenues





Revenues
for the three months ended June 30, 2008, and 2007 were $109,942 and $32,140,
respectively, an increase of $77,802 or approximately 242%. Revenue is derived
primarily from our contracts with Microsoft, Citrix, and SAP.





Cost of Sales and
Margins





Cost of
sales for the three months ended June 30, 2008, and 2007 were $37,659 and
$21,712, respectively, an increase of $15,947 or approximately 73%. Cost of
sales primarily comprise network charges due at our data site.





Operating
Expenses





General
and administrative expenses for the three months ended June 30, 2008, and 2007
were $284,901 and $330,500, respectively, a decrease of $45,599 or approximately
14%. General and administrative expenses consisted primarily non-cash
compensation of $75,925 representing the vesting of stock options to officers;
legal and accounting fees in the amount of $66,255; consulting fees in the
amount of $60,000; payroll and related costs of $30,811; depreciation and
amortization expense in the amount of $23,458; insurance expense in the amount
of $7,530; travel and entertainment costs in the amount of $8,751; facilities
and related expense in the amount of $4,600; and office expenses in the amount
of $1,607.





F-14
 Table of Contents




Other Income
(Expense)





Other
income (expense) for the three months ended June 30, 2008 were expense of
($66,241) compared to  income of $374,759 for the three months ended
June 30, 2007, a net increase in expense of $441,000.  During the
three months ended June 30, 2008 the Company had no derivative liabilities
outstanding and thus recognized no gain or loss from the change fair value of
any  derivative liabilities.  During the three months ended
June 30, 2007, the Company recognized a gain on derivative liability of $620,163
 During the three months ended June 30, 2008 the Company incurred interest
expense of $67,570 compared to $245,877 during the three months ended June 30,
2007. The reason for the decrease in interest expense was decrease in debt due
to the conversion of notes payable during the year ended March 31,
2008.  During the three months ended June 30, 2008, the Company had a
gain on the sale of fixed assets of $1,329, compared to a gain on the sale of
assets of $0 during the three months ended June 30, 2007.  The Company
also had other expenses of $0 during the three months ended June 30, 2008,
compared to other expenses of $1,790 during the three months ended June 30,
2007.





Net Income
(Loss)





For the reasons stated above, our net
loss for the three months ended June 30, 2008, amounted to $278,859 compared to
a net income of $54,687 during the prior period, a net increase in loss of
$333,546.





Liquidity
and Capital Resources




The June
30, 2008, financial statements have been prepared assuming the Company will
continue as a going concern. However, the Company has incurred a loss of
$5,177,120 from inception (January 12, 2005) through June 30, 2008, and has a
working capital deficiency and stockholder deficit of $1,443,907  and
$1,341,493, respectively, at June 30, 2008. The Company currently has minimal
revenue generating operations and expects to incur substantial operating
expenses in order to expand its business. As a result, the Company expects to
incur operating losses for the foreseeable future.  The accompanying
financial statements do not include any adjustments that might become necessary
should the Company be unable to continue as a going concern.




Management
intends to continue to finance operations through financings activities; however
there can be no assurance of successful financings or acquisition activity in
the future.





On
December 22, 2006, the Company entered into a securities purchase agreement (the
"Agreement") with an accredited investor (the "Investor") for the sale of
$1,000,000 Convertible Debentures (the "Debentures"). In connection with the
Agreement, the Investor received (i) a warrant to purchase 8,928,571 shares of
common stock ("Long-Term Warrants") exercisable at $0.30 and (ii) a warrant to
purchase 1,785,714 shares of common stock ("Short Term Warrants") exercisable at
$0.143 per share. The Long Term Warrants and the Short Term Warrants are
exercisable for a period four years from the date of issuance and the earlier of
(i) December 22, 2007 and (ii) the date a registration statement(s) covering the
resale of all Registrable Securities (as defined in the Registration Rights
Agreement) is declared effective by the Commission (the "Initial Exercise Date")
and on or prior to the close of business on the four month anniversary of the
Initial Exercise Date, respectively.





The
Debentures bear interest at 4% until June 22, 2007, and 9% thereafter, payable
in arrears and mature three years from the date of issuance. Accrued interest
will be payable in cash semi-annually, beginning on July 1, 2007.





In
February 2007 we entered into a master leasing arrangement with Gulf Pointe
Capital, LLC for equipment purchases up to a total of $500,000 (see Contractual
Obligations below).





At June
30, 2008, we had current liabilities of $1,520,934. We have no material
commitments for capital expenditures.




Contractual
Obligations




In
February 2007 the Company entered into a $500,000 Master Lease Line for
Equipment Purchases (the “Master Lease Agreement”). At that time, the Company
sold property and equipment for $125,000 and leased them back under the Master
Lease Agreement. The Company recognized a gain on the sale of those assets of
$10,633 which was deferred and will be recognized over the 24 month term of the
lease.  At June 30, 2008, the balance of this deferred gain was
$3,545.




The
Master Lease Agreement calls for draws of a minimum of $100,000, a minimum term
of 18 months and a maximum term of 36 months. The lease entered into in February
2007 has monthly payments of $6,363. The Company accounted for this lease as a
capital lease.




In
connection with the Master Lease Agreement, the Company agreed to issue five
year warrants to the lender to purchase 1,350,000 shares of the Company’s common
stock at an exercise price of $0.18 per share. Ten percent (135,000) of the
warrants vested upon execution of the Master Lease Agreement. The remaining 90%
of the warrants vest as on a pro rata basis as the lender provides funding under
the Master Lease Agreement. As such 303,750 warrants vested upon execution of
the sale lease-back described above. The total number of warrants, 438,750, was
valued using the Black-Scholes method and applied to the capital lease
obligation in accordance with Accounting Principles Board (“APB”) No. 14. This
resulted in a decrease in capital lease obligation of $37,726 and a
corresponding increase in additional paid-in capital.





F-15
 Table of Contents




On April
16, 2008, the Company announced that it had terminated its planned acquisition
of Xalles Limited that had been announced on October 5, 2007. In conjunction
with this planned acquisition,  Xalles had advanced to the Company the
amount of $158,079 to provide working capital for the Company. On April 14, 2008
(the “Effective Date”), Innovative Software Technologies, Inc., (the “Company”),
Xalles Limited, an Irish corporation (“Xalles”), and Meridian Bay Limited, an
Hong Kong corporation (“Meridian”) terminated an agreement to purchase all of
the outstanding shares of Xalles which had been entered into by the parties on
October 1, 2007 (the “Agreement”).  Continued due diligence by the
Company resulted in the Company’s decision to not pursue the acquisition under
the terms specified by the Agreement.





As a
result of the termination of the Agreement and the signing of the Release, and
in order to recognize the obligation of the Company due to a series of
advancements made to it by Xalles, the Company issued a promissory note to the
benefit of Xalles in the amount of $158,079, on April 14, 2008, repayable on or
before December 18, 2008 (the “Note”).  The outstanding principal
amount of the Note bears interest beginning on April 14, 2008, calculated on the
basis of a 360-day year for the actual number of days elapsed through the actual
payment date at the following rates of interest: eight percent (8%) per annum
through June 15, 2008; ten percent (10%) per annum through August 16, 2008,
twelve percent per annum through October 17, 2008; and fourteen percent per
annum through December 18, 2008.  The outstanding principal balance of
this Note, plus accrued but unpaid interest, is due and payable on December 18,
2008.  This Note may be prepaid, either in whole or in part, at any
time without penalty.





Item 3. Controls andProcedures




Evaluation
and Conclusion of Disclosure Controls and Procedures




The
Company conducted an evaluation, under the supervision and with the
participation of the Company’s principal executive officer and principal
financial officer, of the effectiveness of the design and operation of the
Company’s disclosure controls and procedures (as defined in the Securities
Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e), as amended) as of
March 31, 2008.




Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company’s disclosure controls and procedures as of the end of
the period covered by this Report were not effective as a result of a material
weakness in internal control over financial reporting as of June 30, 2008 as
discussed in the 10-KSB for the year ended March 31, 2008.






F-16




PART
II - OTHER INFORMATION





Item1. Legal Proceedings




From time
to time, we may become involved in various lawsuits and legal proceedings, which
arise in the ordinary course of business. However, litigation is subject to
inherent uncertainties, and an adverse result in these or other matters may
arise from time to time that may harm business. Except as disclosed below we are
currently not aware of any such legal proceedings or claims that will have,
individually or in the aggregate, a material adverse affect on business,
financial condition, operating results, or cash flows.





SEC
Investigation





On June
24, 2003, the Securities and Exchange Commission ("SEC") issued a formal order
of investigation, authorizing the investigation of certain securities matters.
The SEC staff has taken the testimony of certain officers and previously
management had voluntarily provided documents and information to the SEC staff
in response to informal, non-public inquiries by the staff. On April 8, 2005,
the Independent Committee of the Board of Directors turned over the results of
its investigation to the SEC. On June 25, 2007, the SEC notified the Company
that it had concluded the investigation as it relates to the Company and was not
recommending any enforcement action.





Kansas City
Explorers





We are a
defendant in a lawsuit in the Circuit Court of Platte County, Missouri, "Kansas
City Explorers vs. Innovative Software" Case no. 04CV82050 in which the claimant
is seeking money for advertising which it alleges is still due, and have alleged
damages of $50,028. The claimant has been court ordered to produce answers to
certain discovery requests of ours which they have failed to produce. Management
intends to aggressively defend the claim based upon the lack of contract between
the parties, lack of proof of damages, as well as minimal proof of advertising
services actually performed for our products and services.





Item2. Unregistered Sales of Equity Securities and Use of
Proceeds





On May
30, 2008, the Company issued shares of common stock at a price of $0.05 per
shares for previously accrued salary in the amount of $31,500 to the Company’s
Chief Financial Officer.  A total of  630,000 shares of
common stock were issued to the officer.





On May
30, 2008, the Company issued shares of common stock at a price of $0.05 per
shares for previously accrued salary in the amount of $35,000 to the Company’s
Executive Officer.  A total of  700,000 shares of common
stock were issued to the officer.




All of
the above issuances and sales were deemed to be exempt under Rule 506 of
Regulation D and Section (2) of the Securities Act of 1933, as amended. No
advertising or general solicitation was employed in offering the securities. The
offerings and sales were made to a limited number of persons, all of whom were
accredited investors, business associates of Innovative Software Technologies,
Inc. or executive officers of the Company, and transfer was restricted by the
Company in accordance with the requirement of the Securities Act of
1933.




Item3. Defaults Upon Senior Securities





None





Item4. Submission of Matters to a Vote of Security
Holders




None.




Item5. Other Information





None.




Item6. Exhibits.




Exhibits
included or incorporated by reference herein are set forth in the attached
Exhibit Index.






1
 Table of Contents




SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.







Innovative Software
      Technologies, Inc.Date: August 14,
      2008
            
            /s/ Philip D.
      Ellett
              Philip
      D. Ellett
              Chief
      Executive Officer




Date: August 14,
      2008
            
            /s/ Robert V.
      Rudman
              Robert
      V. Rudman
              Chief
      Financial Officer











2
 Table of Contents







INDEX
TO EXHIBITS





ExhibitNumber
            
            Description31.1
            
            Certification of Chief Executive Officer of Innovative
      Software Technologies, Inc. pursuant to Rule 13a-15(e) or 15d-15(e) of the
      Securities Exchange Act of 1934, as amended.31.2
            
            Certification of Chief Financial Officer of Innovative
      Software Technologies, Inc. pursuant to Rule 13a-15(e) or 15d-15(e) of the
      Securities Exchange Act of 1934, as amended.32.1
            
            Certification of Chief Executive Officer of Innovative
      Software Technologies, Inc. pursuant to 18 U.S.C.
  1350.32.2
            
            Certification of Chief Financial Officer of Innovative
      Software Technologies, Inc. pursuant to 18 U.S.C.
  1350.








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